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Summary

  • Citigroup provides the most bang for your buck compared to its peers.
  • Positive stress test results will be a major catalyst for the stock.
  • A rising rate environment and a steepening yield curve are positive for banks.
  • Valuation and fundamentals are still very reasonable on a historical basis.

Citigroup (NYSE:C) is the leading global bank. The company has approximately 200 million customer accounts and does business in more than 160 countries and jurisdictions. Nevertheless, the bank has not participated in the huge rally over the past year.

(click to enlarge)

(Chart provided by Finviz.com)

Citigroup is up 9% over the past 52 weeks and actually down 3% over the last six months. I submit to you that this is a major buy. In the following sections I will lay out my bull case for the stock going forward.

Citigroup is a steal compared to its peers

Citigroup is vastly undervalued compared to the other global money center banks. Further, Citigroup has the greatest potential upside as well. The bank is trading for the lowest PEG ratio of 0.9 out of the five major banks right now.

(click to enlarge)

(Table provided by Finviz.com)

Further, Citigroup has the lowest trailing and forward P/E ratios of the five major banks at 11.79 and 8.78, respectively. Yet, the stock has gone virtually nowhere over the past year. Why you say? Well there has been little movement in regards to returning wealth to shareholders. I posit that is about to change when the payout ratios are released on the 26th. A recent Bloomberg article underpins my thesis ...

"The biggest increase in payouts may come from Citigroup Inc., ranked third by assets and run by Chief Executive Officer Michael Corbat, 53. The New York-based firm could return $6.6 billion in the year beginning April 1, compared with $121 million in the previous 12 months, according to an average of four analysts' estimates compiled by Bloomberg. The predictions range from as much as $8.2 billion to as little as $4.7 billion."

Did you catch that? They said $121 million over the last 12 months versus potentially $6.6 billion over the next 12 months. That is an exponential increase. I believe this will be a seminal moment for the stock.

Citigroup passed the stress tests with flying colors. Nevertheless, there are risks. According to Chris Kotowski, an Oppenheimer & Co. analyst,

"Citigroup's request may be complicated by a $400 million fraud the bank reported last month after it found falsified documents tied to loans made by its Mexican unit to an oil-services firm."

Even so, I don't see this development throwing a monkey wrench into Citigroup's plans for future dividend increases and share buybacks. I posit it was an isolated incident.

At present, Citigroup is not on an income investor's radar due to the fact the yield is still insignificant. Nevertheless, as Citigroup increases the annual payout and the yield rises I expect the income investor to take notice.

Rising rates and a steepening yield curve are big positives.

The yield curve steepens when the gap between the yield on short-term bonds and long-term bonds increases. This makes the curve appear steeper. Banks borrow short and lend long. As the spread between the 10-year and 2-year bond yields widen, the bank's profit margins rise. The 10-2 year treasury yield spread is currently at 2.32%, and rising.

(click to enlarge)

(Chart provided by Ycharts.com)

Another significant positive regarding a steepening yield curve is the fact it is a clue to the direction of the economy. When the yield curve steepens, it portends the economy is on an upswing.

Citigroup is extremely undervalued

Citigroup has a current price to book value ratio of 0.9. Historically, Citigroup has traded for closer to two times book value. This implies significant potential upside from current levels if the stock can simply return to historical levels. This data squares well with the historical price performance of the stock. Moreover, profits are up as well.

(Tables provided by Scottrade.com)

Downside risks

Macroeconomic and geopolitical headwinds emerge

If something goes awry in China, Europe or the Middle East the markets will be negatively affected. No stock will be immune. The current "wall of worry" seems to be growing taller. This concern is amplified by the fact the market is still near all-time highs. This is a potent combination.

Legal risks still remain

Citigroup has not yet put the entirety of the company's legal risks behind it. Legal challenges from investors in mortgages and mortgage backed securities could still prevail against the bank.

The housing market craters

With rates on the rise, the housing market could take a hit. The housing recovery is still in its infancy. It remains to be seen if the housing market can with stand higher mortgage rates. Although Citigroup has less exposure to the housing market than other banks, a major pullback in the housing market would not bode well for the stock.

Conclusion

Citigroup is a solid buy right now. Although the stock has not performed well over the past year, the bank is now the only major bank stock trading for a single digit forward P/E ratio. Moreover, earnings continue to increase. EPS is expected to grow significantly this year and in 2015 as well.

I see a major opportunity ahead for Citigroup shareholders. I do not believe all the future positives have been priced in the stock. With the yield curve steepening and Citigroup cleaning house, I posit the bank will become much more profitable and increase distributions to shareholders. If you choose to start a position in the stock at this time, I suggest layering in a quarter at a time to reduce risk.

Source: Why Is Citigroup The Best Bank To Buy Today?